Swap in Forex – FX Guide

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A foreign currency swap in Kenya also referred to as an FX swap, is a negotiation between two foreign parties to exchange currencies. By using the agreement, the principal and interest payments of a loan made in one currency are exchanged for a loan of equal value made in another currency. Thus, an entity borrows currency from another entity while at the same time lending that entity another currency.

Swapping takes place when you hold an open position overnight in Forex. The amount credited or debited to your account depends on the direction and trading pair of the trade. So let’s move straight to the overview of swap in Forex trading and how you can use it to make a profitable trade.

What is swap in Forex?

In the evenings, at exactly 10 PM GMT (time might vary with some brokers), a trader holding an open position in the FX market overnight will either credit or debit their trading account.

Depending on the established account margin and position on the market, the value of this charge is an interest charge on the full size of open positions. In addition, a Kenyan trader may owe or receive interest fees based on the interest-rate differential called rollover fees.

Rollover fees are assessed when an open position from one value date (settlement date) extends onto the next value date. FX brokers automatically execute rollovers if a Kenyan trader holds open positions beyond the date of change in value.

It takes two business days for the settlement to be completed behind the scenes. Consequently, if Monday is before 10 PM GMT, Wednesday is currency trading day. When the trade date reaches 10 PM GMT on Monday, it becomes Tuesday, and they are exchanged for value on Thursday.

Positions that are open at 10 PM GMT are subject to swap charges.

Rollover is applied after 10 PM GMT on open positions, whether a change of value or settlement date. If traders do not hold open positions over the change in value date, there will be no rollover charge or debit due; therefore, if a trade is opened and closed before 10 PM GMT, on the same day, there will be no rollover charge or debit due.

Rollover of three days occurs on Wednesday.

As of 10 PM GMT Wednesday, the value date has rolled over from Friday to Monday, a weekend rollover, which means it will be a three-day rollover (Saturday, Sunday, Monday). Consequently, the rollover costs and gains are going to be tripled compared to any other day.

Understanding foreign currency swaps

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A currency swap is usually used to obtain loans in a foreign at a more advantageous interest rate than could be obtained from borrowing in a foreign market directly. First introduced by the World Bank in 1981, currency swaps were a method of obtaining German marks and Swiss francs. A currency swap differs from an interest rate swap in that it involves principal exchanges as well.

Both parties continually charge the swapped principal amounts interest throughout the swap.

Once the swap is completed, principal amounts are exchanged a second time at a prearranged rate (which eliminates transaction risk).

Currency swaps can be divided into two categories. Fixed-for-fixed currency swaps involve exchanging fixed interest payments in one currency for payments in another currency. Swaps of fixed to floating interest payments involve exchanging fixed interest payments in one currency for floating interest payments in another. Swaps in which the underlying loan is not exchanged do not change the principal amount.

Examples of foreign currency swaps

Utilising a currency swap is a common way of securing the cheaper debt. An example would be European Company A borrows $120 million from US business Company B, while at the same time European Company A lends 100 million euros to US business Business B. In this case, the spot rate is $1.2 indexed to the London Interbank Offered Rate (LIBOR). Therefore, this deal offers the most favourable borrowing rates.

Furthermore, some institutions use currency swaps to reduce the impact of anticipated exchange rate fluctuations. For example, US Company A and Swiss Company B can reduce their respective exposures via currency swaps if they seek each other’s currencies (Swiss francs and USD, respectively).

In 2008, when several developing countries faced liquidity problems, the Federal Reserve provided them with the option of borrowing through currency swaps.

How can you calculate Forex swaps?

Trading forex involves buying or selling the base currency to express your outlook on a currency pair.

In essence, you agree with us as the counterparty to take a view in one currency before switching it back to another at the time of your choice, any running profit or losses being posted to the account.

It would help if you held a position according to your trading plan and strategy. For example, positions are held for days or weeks in swing trading, whereas in scalping, a position is held for a few seconds. A trader shouldn’t focus only on the price of the currency pair they’re trading; they should also be sensitive to the swap or funding charges.

As with any swap, the swap charge is heavily influenced by the underlying interest rate associated with each currency. The swap charge will be applied if you hold the position at the daily rollover point, which is 00:00 server time and also referred to as the “tomorrow next” or “tom next” point in forex trading.

Because intraday traders close their positions before the daily rollover point, swap charges won’t impact them. However, if you hold a position overnight or longer, you must consider this when making your trading decisions.

How is rollover interest calculated?

Interest rate differences are the driving force behind swap charges. Another way of describing the interest rate differential is a percentage difference between your base and quoted currency.

It is common for differences between the two interest rates, so once we net these off and calculate the differential, you might be charged – or even receive – an amount of interest each day.

This number is affected by several factors, including the size of the lot, the market price, and the extent of the interest rate differential at the time. A carry trade is based upon this differential.

What is a carry trade?

Trading strategies often involve actively taking positions in a currency with a higher corresponding interest rate, shorting the currency with a lower interest rate, and then netting the difference in interest rates.

This is called the carry trade, where the Kenyan trader carries over their position to earn interest and collect the interest differential. Carry is one of the most important aspects of the FX market and is taken into account by many hedge funds.

Why do brokers charge swaps?

Among the features, Kenyan offers its clients is the ability to actively trade price changes in global currency markets without physically delivering the traded currency. In other words, we enter leveraged FX positions on a rolling settlement basis that is open-ended.

A trader decides when to close a position by using a stop-loss or other trade management method, while brokers calculate funding charges by using the rollover period as an alternative to the delivery of currency pairs.

How does settlement occur in the Forex spot market?

FX spot transactions on the underlying market are normally settled two business days after the trade date ( T+2). Thus, an institution that buys EURUSD will receive EURs at the agreed rate two days after purchase on the spot FX market. The USDCAD currency pair settles the day after the trade (T+1) is one exception to this rule.

What is Tom next?

Financial instruments like Tom Next swaps can be traded. However, rates fluctuate along with monetary policy expectations and other market factors such as supply, demand, and liquidity. As a result, institutions often enter into Tom’s next arrangements in an attempt to delay settlements.

Example of a Tom next swap

Assume a trader purchases one contract (€100,000 notional) of EURUSD, but for some reason, he wants to delay settlement by a day. So, on the next business day, the counterparty swaps the €100,000 back to the trader at the previous transaction rate plus the additional rate for the “next” trading day.

As a result, the trader’s settlement has been pushed back by one day, and their exchange rate is adjusted to the market’s next rate.

We duplicate this exact process by managing our client flow with hedging banks in the same way. As a result, the credit (or cost) of rollovers and delays is replicated to your account.

By continuing to hold a position beyond the set rollover time of 5 PM New York time (or 7 AM AEST), you will be subjected to the Tom next charge on your nominal position along with any profits or losses that may occur.

The swap rate is also considered in the physical FX world when adjusting the previously agreed opening price. With leveraged FX trading, which is what we offer, you can adjust your account balance.

How can we get our Tom next rates?

An investment bank of tier-one status sources our Tom next rates for us. Updates are made regularly to account for the dynamic nature of the market.

Swap charge/credit = (1 point/exchange rate) x (trade size [or notional amount] * tom next charge)

For example:

  • Currency pair = EURUSD
  • One point = 0.00001
  • Account base = EUR
  • Exchange rate = 1.1290
  • Trade size = 1 lot (€100,000)
  • Long swap rate = 11.49
  • Short swap rate = +7.02

Swap value required to debit from account:

(0.00001/1.1290) * (100,000 * -11.49) = €-10.18

In the case of EURUSD, you’d receive €6.22 a day if you were short one contract.

What is a triple swap?

In the industry, three-day rollovers are the norm. Kenyan Traders will be charged (or credited) the Tom next rate if their positions remain open past 5 PM New York time, but the three-day rollover charge, also known as triple swap Wednesday, is by far the most confusing part of the rollover.

The reason for this is because if a Kenyan trader holds a position past 5 PM New York time on Wednesday, the trade is deemed to have been executed on Thursday, and the three days of interest are deducted from the account.

As T+2 settlements take place on Monday, the broker is exposed to settlement on Monday, resulting in funding charges (or credits) for both days of the weekend for the trader. Thus, the FX market is closed, the three-day Tom next exposure is calculated in calendar days.

Three ways to avoid paying swap rates

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Avoiding swap rates is possible in at least three ways.

  • The trade should move in the direction of positive interest.
  • Traders can only go in the direction of currencies with positive swaps. However, back-tested and forward-tested results indicate that trading in that direction is generally not recommended unless it is the most favourable direction.
  • Trading should be done only intraday, and positions should be closed by 10 PM GMT (or whenever your broker rolls overstocks).

The swap would be avoided since you are in and out before the time for rollovers. Although the swap affects your trading, you should not turn into an intraday trader purely for its sake. Getting into intraday trading should be based on either your strategy or your performance results. The swap should not be the reason.

Open a swap-free Islamic account, offered by some Kenyan brokers

Muslim customers have the option to select this category, although, in reality, many non-muslim do. The specific type of account is run according to Islamic beliefs, including paying no interest on a business transaction. You may want to consider opening a swap-free Islamic account if you believe you will be transacting many overnight transactions.

Bottom line

Forex swaps refer to the interest that is charged when an open position is held overnight. Fees associated with swaps are known as rollover fees. Interest rate differentials refer to the difference between two currencies’ interest rates. Traded pairs and trade directions will be calculated based on interest rate differentials so that trading accounts will be credited or debited accordingly.

Over-the-counter derivatives such as currency swaps have two primary purposes. In the first place, they can be used to minimise borrowing costs internationally. A second benefit is that they may be used to hedge exposure to exchange rate risk.

Corporate clients with international exposure typically utilise currency swaps for this purpose, whereas institutional investors use currency swaps as part of comprehensive hedging strategies.

Borrowing money in Kenya may also cost more than in other countries, or vice versa. However, taking out loans from the home country gives a domestic company an advantage over international companies because its cost of capital is lower.

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